It’s So Good Being Bad: How To Build A Profitable Strategy

Sometimes in order to truly understand a system or a task you have to try really hard to suck at it before you can comprehend what success means.

If you are having trouble trying to figure out what makes a trading strategy profitable take a step back for a minute and think about what you would need to incorporate into a strategy to make it horrible. Think of every way you could lose money and then one piece at a time deconstruct the system and rebuild it with the inverse of those elements. 

The trick here is to keep things simple and make sure you understand the problem domain you are handling. For example if you think overtrading is a sin, as I do, then the first thing on your list may be “make 100 trades in a day”. Obviously, if you were to make 100 trades in one day you would have to execute a trade ever 3 minutes or so (if I did my math correctly). From that you can incur the root issue with making 100 trades in a single day. Problems that revolve around momentum and your account size (which could translate to having to do with risk management). So, those are two domains you need to understand to write a trading system backed by substantial logic. 

What I have found, when it comes to any sort of creative process, is that getting the ball rolling usually the hardest step. 

Free Advantages

If you ask any economist he would tell you there is no such thing as a free lunch. 

This is true, but we can sometimes turn things that seem like a disadvantage into an inherit advantage, and that sure feels free enough to me!

One free advantage the market builds in is based on liquidity. Most large funds have major advantages over small investors in the way that they can shape, and have an actual impact, on market pricing or movements. However this comes at a cost.

Large funds have a lot of trouble moving in and out of the market. They can crash a stock trying to liquidate, and are (sometimes) forced to average up when purchasing a stock because their purchase may eat through all the pending orders at various price levels. Individual investors do not have this problem and do not need to execute or engineer an algorithm for the sole purpose of trading out a position. How is this an advantage?

This allows small investors to make tons of mistakes without having to pay a large penalty for being overactive. I could trade in and out of 40 positions in a single day and although the commissions would sting a good bit it probably wouldn’t wipe out my account. You can run circles around the positions of large hedge funds, and this agility leads to some interesting strategies.

A lot of those strategies involve risk management, but this advantage, the gift of liquidity immunity, can save (and make) you a lot of money.

Observe what happens when liquidity disappears from a market, or starts to manifest for the first time. Also, think about how obvious your position would be if you were a hedge fund. How would this be problematic? Hedge funds have special algorithms they use to buy and sell stock in a way that disguises their position for as long as possible. Once you understand why that is vital to the success of a mutual or hedge fund it will enlighten you on several strategies for both entries and risk management.

Good luck and happy trading! 

Time Frame Arbitrage?

Went to a financial conference last night. It involved a series of prepared questions which were addressed to the six panelists representing various hedge funds and firms.

One of the panelists brought up time frame arbitrage. I do not think there is such a thing. I think I know what he was thinking about, but TFA does not really exist. It is in itself an oxymoron. Arbitrage must be settled immediately for an instant profit. A free lunch in a sense. But seldom does the market offer such opportunities (one instance was during the crash of 1987).

I think he was just referring to people overreacting. Lack of liquidity can cause panic, panic can cause rapid selling, rapid selling can cause extreme “mis-pricings”. The people that trade their assets in the market for cash are forgoing the benefit from the recovery of a sell-off (profit in a longer time frame) for immediate safety (shorter time frame). That is what our friend truly meant. I think.

Your 401k Sucks — Here’s Why

My father approached me the other day regarding the investments he has been making in his 401k. He asked me to take a look at the funds he is invested in and give him my opinion on what he should do. The account had done virtually nothing for the past 5 or 6 years, and I made a quick estimation, using excel, on what the account would be worth the day he plans to retire. I showed him the figures my analysis pumped out, and he was no doubt surprised. It was a lot lower then what he expected.

It does not take a ton of effort to plan for retirement, however most people are not versed with enough investing knowledge to make these life changing decisions on their own. Shockingly, neither are a large majority of the people who deem themselves “qualified”.

Read a few books and just get the basics down. It is a lot better if you self-direct your 401k, that is if you have the time and care about when/if you retire. Of course, consult any professional on their opinions as well, but you should at the very least educate yourself so you can keep up with the jargon and understand the process that is impacting a huge percentage of your life.

What Kind Of Trader Are You?

Most traders confuse themselves. They sit down at their desk with an idea. An idea that they hardly understand. You have to define what your trading goals are before you press buy or sell. Break down your strategy and figure out exactly what you are exploiting. Why does your strategy work? That is the question you must answer before you really begin to make money in the markets.

You can blow off this message as I did for the longest time. You will look at the MACD or maybe your trendlines and think that your trading strategy is bulletproof. How can you say something like that unless you have dug deep into the surface of your ideas and truly understand what you are doing when you push buy and sell.

Or you can embrace this message and take a step back. Go over your strategy and figure out the core concepts behind what you do. This will not only greatly enhance your faith in what you do (this is especially important when one experiences a string of losses), but it may also point out massive holes in your strategy that could have eventually cost you a lot of money.

Do yourself a favor and ponder these questions:

What kind of trader am I? Why do I make money in the market? Where is the logic in what I do?

If you can not answer those questions you are not ready to trade. I would say 98% of people trade without first being able to obtain the answers to the above quesitons… Which is an oddly familiar statistic…

I’m Back!

Hello Traders,

It has been quite some time since I have posted on this blog. My methods have drastically changed. But I still stand by 99% of everything I have posted on this site thus far. Learning to trade is a journey and everything I did led me to where I am today.

I urge those who are finding trading to be a less than profitable experience to continue learning and pushing toward success. It takes some people as long as 10 years to achieve such a goal, but all would agree that it is worth the hardships they faced. The very hardships you are currently facing.

 

Market Sense

When a methodology or system you are using to trade sends out a signal that there is an opportunity present, sometimes you need to have enough “market sense” and discipline to ignore it. The system itself can only be used as a guide, if you purely trade the system it will eventually fail. For example,  a system that relies on a moving average has to have inputted parameters. Those parameters do not change with the market. Markets are an ever changing entity. There is constantly an increase and decrease in volume/activity, and parameters are not built to adjust to such changing conditions, and therefore you need a countermeasure to make sure your method stays robust. That is where logic and market principals come into play. Trading is multi-dimensional, most traders fail to see this. Ask an average trader why their system works, and he wont be able to tell you, he doesn’t understand the logic behind his method, and is in turn doomed to failure.

The Road To Riches: Giving Up

How do you minimize your losses?

Give up.

The reason most traders “blow up” their accounts is by letting their losses get out of control. You have been trained and conditioned your whole life to think positively and never to give up or back down. That sort of thinking will reek havoc on an equity curve.

The trick is to enter every trade with the mindset that you are wrong. Being able to admit defeat is probably the most admirable trait a trader can have.

Do Not Buy The Lies

I have been seeing the same headlines recycled over the past few weeks. Like clockwork every time the market rallies the headlines read “Is this the market bottom” and “great stocks to buy”.  When the market begins to slump once again, all the doom and gloom economists make the front page with their predictions on the length and magnitude of this volatile decline.

Do not buy into the lies. Look at what the trend is telling you and never ignore the macro condition of the market. Be patient and your opportunity to buy will present itself soon enough.

The Only Thing You Should Try and Pick is Your Nose

Trying to consistenly pick tops, and in this case bottoms, is a dangerous game. Leave this up to the professionals, the professionals who want to lose their jobs and client’s money.

Wait until a clear cut uptrend has formed before going long in anything. Don’t get caught with your finger up your nose.

Remember, a trend only reverses once. Think about that statement for a while, its a testamate of how easy trading can be.